U.S. Stocks Showing Signs of Weakness Ahead of Earnings Season

North American stocks continue to perform well overall, but there are headwinds that could stall that momentum. The unexpected call for President Trump to be impeached, the ongoing trade war between the U.S. and China, and a slowing global economy are just a few of the issues that could derail the bull market. Or rather, are beginning to. The stock market is a forward looking indicator, and third quarter earnings expectations are not looking good. This suggests the markets will face downward pressure.

There are many, many reasons why the broader stock market rises and falls. In the lead-up to earnings season, investors take stalk in what Wall Street CEOs are expecting. If they are optimistic, the bulls step in; but if they’re not, investors hesitate and buying slows down. That’s what we’re beginning to see right now.

The third quarter of fiscal 2019, which ended September 30, has wrapped up and earnings season is, once again, upon us. It’s time for corporate Canada and America to show us how they’re performing. The economic indicators suggest the U.S. and Canadian economies are performing well. But again, concerns about a trade war between the two largest economies in the world and how it will affect stocks cannot be discounted. There are signs that cracks are beginning to appear on Wall Street and Bay Street.

For the third quarter, the estimated earnings decline for S&P 500 stocks is -3.8%. If that is the actual decline for the third quarter, it will be the first time the S&P 500 has reported three consecutive quarters of year-over-year declines since the fourth quarter of 2015 through to the second quarter of 2016. This would also represent the largest year-over-year decline in earnings since the first quarter of 2016 (-6.9%).1

The earnings outlook for stocks has becoming increasingly worse. Back on June 30, the estimated earnings decline for the S&P 500 was “just” -0.6%. Compared to June 30, all 11 sectors have lowered their growth rates as a result of downward earnings per share (EPS) estimates.

While only 113 S&P 500 companies have issued earnings guidance for the third quarter, 82 of them (72.5%) have issued negative EPS guidance. The percentage of S&P 500 listed companies issuing negative EPS guidance is above the five-year average of 70%.

But what about revenue? After all, there are a lot of reasons why a company may need to lower its earnings guidance. Revenue on the other hand, some may argue, is a better indicator as to the health of the broader economy.

The projected year-over-year revenue growth rate for the third quarter is a paltry 2.8%; far below the five-year average of 3.5%. The difference might not sound like much, but it’s a 20% drop in revenue. Should 2.8% be the actual growth rate for the third quarter, it will be the lowest revenue growth rate on the S&P 500 since the third quarter of 2016, when it was 2.7%.

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  1. “Earnings Insight,” Factset, September 20, 2019; https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_092019A.pdf.

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